APA's bid looking like a missed opportunity

By Malcolm Maiden

10 June 2008 — 12:00am

WALL Street's 3.1% plunge on Friday can be partly reversed if loose talk about an Israeli attack on Iran is hosed down by the Israeli Government: the talk lit the fuse on a record $US10.75 leap in the price of oil to a new high of $US138.54 a barrel - and it was oil's surge combined with news that the US unemployment rate had jumped from 5% to 5.5% that kindled fears of stagflation, and sent shares tumbling.

Oil was down by about $US1 a barrel in Asian markets yesterday after an Israeli Government spokesman said all Iran options remained on the table. But to say that $US130 a barrel-plus oil and a possible recession in the world's biggest economy is a toxic cocktail is an understatement: in this market, there are short-term offsets because energy shares are being boosted by the oil price. But investors with a negative exposure to the oil shock are looking at more sharemarket pain - none more so than shareholders in Qantas.

It was just over a year ago that Airline Partners Australia lost its bid to take over Qantas, with a cash bid pitched at $5.45 a share. Ahead of trading today, Qantas is sitting at $3.49, off a low of $3.26 set on May 27, but almost 36% down so far this year, and 42% off its high of $6.06, set in October last year, when the market was rallying in the mistaken belief that the subprime fiasco was history.

Virgin Blue, Qantas' domestic competitor, is flying even closer to the ground, with its shares down 70.5% this year. But that is cold comfort for Qantas: only very long-term Qantas shareholders (Andrew Sisson's Balanced Equity, which opposed the APA offer and recently topped up its stake by about 1% to 6.4%, is probably one) can argue now that the Qantas takeover was not a missed opportunity.

Despite all the market ructions since mid-2007, if APA had got past 50% (it fell a hair's breadth short after being gamed by hedge funds), the cheques it sent to shareholders would not have bounced. Bridging funding for the bid was supplied firm, first at $12 billion for a 100% takeover and then, in April last year, at $7.5 billion for a bid that only needed to get past 50%.

Advertisement

That second facility was,

in effect, the world's biggest margin loan and, like the money to fund the full takeover, it was made available not only without the standard covenants that can trigger repayment demands if the borrower gets into financial difficulty, but with provisions for interest to accrue if necessary.

The banks involved - Morgan Stanley, Deutsche Bank, Citigroup, Goldman Sachs, Royal Bank of Scotland and Calyon - would probably not have been able to quickly re-syndicate the bridging debt as the subprime crisis flared. But that would have been their problem; the takeover itself would already have been funded, and the oil price pressure that later emerged would not have been fatal for APA.

Just before Qantas recommended APA's bid in December 2006, it predicted that pre-tax earnings in the year to June 30, 2007, would rise by between 25% and 30% compared with 2005-06. For 2006-07 it actually lifted pre-tax earnings by 53.8%, to $1032 million. This is an earnings base well beyond APA's original estimates and, although fuel costs have soared, Qantas has stuck to a prediction that extensive fuel price hedging will enable it to post a 40% higher pre-tax profit in the current year to June.

In 2008-09, the airline is only about 59% hedged at much higher prices. It is cutting routes, grounding older aircraft, freezing executive pay, resisting wage claims and trimming its workforce, but the average of broker research estimates is that earnings will still drop by about 39% in 2008-09 - and the range of estimates of the profit fall, from 20% to 70%, highlights that the situation is uncertain.

Even in the worst-case scenario, however, Qantas would be far from insolvent and, on the average earnings prediction, it will earn as much as it did in 2006-07.

And the terms of the APA takeover funding were so generous that even in a year as tough as 2008-09 promises to be, APA would probably have stayed in the pilot's seat. No covenants would have been breached by a profit decline, because no covenants existed. And if Qantas' earnings were insufficient to service the debt, interest charges could have been rolled.

The presence of David Coe's Allco group in the consortium would have been a problem given Allco Finance Group's subsequent implosion in the subprime credit squeeze, but it would not have been a terminal one.

The APA consortium was led by two foreign private equity firms - Texas Pacific and Onex - and by Macquarie Bank and Allco, which had an 8% economic stake through its head company, Allco Finance Group, and a 27% stake through its listed investment affiliate, Allco Equity Partners.

The APA partnership agreement called for a financially straitened partner to sell its stake. Sources familiar with the agreement say Allco's subprime problems would probably have seen Allco Finance's holding sold - but not the separately financed Allco Equity Partners holding.

Texas Pacific, Onex and Macquarie could not have bought Allco Finance out, because foreign ownership of the consortium was already at the 49% limit, and because Macquarie was limited to less than 15% by virtue of its ownership ties to Macquarie Airports. A new partner would have been needed - but I suspect it would have been fairly easily found: APA's first calls would have gone out to Australia's big industry funds.